Wichita has two employee retirement plans, one for police and fire, and another for other employees. The two plans are nearly equal in size, and both experience the same problems.

As a result of low investment returns, the city finds itself saddled with higher retirement plan costs. In 2009, the city’s contribution to Wichita Employees’ Retirement System was $3,887,085. For 2011, it is $7,695,317, an increase of 98 percent in two years. In reality this increase, as large as it is, is not nearly enough to fund the plan if realistic assumptions and accounting was used.

In the words of report authors, the Wichita Employees’ Retirement System plan experienced a “large increase to the unfunded actuarial liability.” In plain language, the plan’s investments did not earn enough in 2011 to meet expected future expenses. This is termed, again by plan authors, an “unfavorable experience.”

The reality is worse than reported, as Wichita uses a valuation method called “asset smoothing.” This technique smooths out uneven investment returns. It means that the recent years of investment losses are not fully incorporated into the official statistics. Again, from the report authors: “Under the asset smoothing method used in the valuation process, a portion of this investment loss is deferred to future years.” Private sector pension plans can’t do this.

As of December 31, 2011, the actuarial value of the plan’s assets — determined using the asset smoothing technique — was $513.3 million. The market value was $458.8 million, or 10.6 percent less. Also, a measure called “Portion of Actuarial Liabilities Covered by Reported Assets” has declined from 90.1 percent in 2009 to 73.9 percent in 2011.

The effect of this unrealized loss on the plan is severe. If these losses were recognized, the city would have to increase its contributions to the plan by a large amount, write the authors: “If the deferred losses were recognized immediately in the actuarial value of assets, the funded percentage would decrease from 93% to 83% and the actuarially determined contribution rate would increase from 12.6% to 17.9%.” (It’s important to remember who pays for these contributions: Wichita taxpayers.)

A chart in the report shows the expected city contribution rate for future years. It rises rapidly, from about 10 percent now to over 16 percent in 2015. This assumes that the plan earns 7.75 percent investment returns.

The ongoing problem

The Wichita retirement plan uses an assumed rate of return of 7.75 percent. Calculations as to how much the city needs to contribute are based on this assumption. The problem is that this rate is simply too high.

In the private sector, pension plans use much lower assumed rates, such as the rate of return on high quality corporate bonds. This might be somewhere between five percent and six percent. If the Wichita retirement plans were re-evaluated using this assumption, the unfunded liability would explode, and the contributions the city would need to make would be much greater, perhaps by one-third. That’s because of the long time frame of pension fund investments, where small changes in rates of return have a large dollar impact.

Solution going forward

The ongoing problem is that city and state pension plans operate under unrealistic assumptions. This means that Wichita is taking on too much risk in the form of future promised benefits that it isn’t presently paying for.

It’s also easy for cities and states to promise generous retirement benefits without paying for them. The solution is to simply stop this practice and adopt what most of the private sector has: Defined contribution plans like 401k plans.

The city has done this, partially, as new employees (not police and fire) are initially in a defined contribution plan. But employees can later decide to move to the defined benefit plan — the type that causes so much trouble for state and local governments. As it turns out, almost all eligible Wichita employees choose to enter the defined benefit plan.

Government employee representation groups are strongly in favor of defined contribution plans. Last year, in its message to its followers, Kansas National Education Association (KNEA, the teachers union) wrote this about defined-contribution plans: “First, they claim that a DC plan gives the employee control over their own retirement. And if you have lots to invest and have the time and knowledge to do so effectively, that might be true. Of course, even if you do, you can end up like the folks who found Enron to be a great investment or trusted Mr. Madoff. The fact is most of us are not prepared to do our own analysis and investment.”

(While KNEA is writing about KPERS, the state employee retirement plan, the principles apply to the Wichita plan.) There’s quite a bit of misinformation here. But before that, a huge irony is that this information is aimed at Kansas schoolteachers, and their union assumes they are not intelligent enough to plan for their own retirement.

In fact, planning for retirement is quite easy and simple. All one needs to do is select low-cost index stock and bond mutual funds, of which there are many. These funds, over the long time horizon appropriate for retirement investing, beat the performance of all managed funds, meaning funds managed by professionals who attempt to analyze markets and earn greater than average returns through an active trading strategy. This is not disputed by anyone except by those who sell actively-managed mutual funds.

“The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period. Even the very few professional investors who have beaten the market over long periods of time — Berkshire Hathaway’s Warren Buffett and Yale University’s David Swensen, for instance — are quick to advise that investors are likely to be much better off with simple low-cost index funds than with expensive actively managed funds.” (Burton G. Malkiel, ‘Buy and Hold’ Is Still a Winner. Also, see the author’s book The random walk guide to investing: ten rules for financial success.)

Generally, most investors would select just one or two funds in which to place their contributions. Over time, investors may want to change the balance or characteristics of the funds they invest in. This again is easy to do. In fact, large mutual fund companies like Vanguard have index funds that automatically shift the balance between stocks and bonds as investors move along towards retirement.

The idea that the teachers union believes that professionals like schoolteachers are not capable of becoming informed and making these decisions is laughable if it weren’t the actual belief of the union. Suggestion: An actually useful and productive role for the teachers union would be to help their members learn to invest for their retirement. Cities like Wichita could do the same.

The problem cited about Enron and Madoff is that some people placed all or nearly all their investments with these two firms. That’s a bad strategy for anyone to follow with their retirement investments. Using index funds will not expose investors to the risk of losing all their money.

The claim by the KNEA that “lots to invest” is required is false. The companies that manage defined-contribution retirement plans accept new employees into the plan no matter how little they have to invest, and they accept their periodic contributions each pay period no matter how small. Scale — the amount available to invest — is not an issue, contrary to the assertions of the teachers union.

One claim made by KNEA is true: defined contribution plans give workers control over their retirement savings. This is a benefit. If a worker has a low tolerance for risk, they can keep their contributions in cash (actually treasury bonds would be the choice for these people). Others who wish to take an active role in the retirement investing can do so, as most plans offer funds that have targeted goals such as real estate, growth stocks, short-term bonds, long-term bonds, etc.

But in KPERS — and the Wichita plan — all members are invested in the mix of investments that the plan trustees decide on. These investments are largely in stocks and bonds, a fact possibly lost upon Jane Carter of Kansas Organization of State Employees. She asked her members “Do you really want to take your retirement security and gamble it on the stock market?” The reality is that KPERS is invested in the stock market, and those returns are essential to funding KPERS benefits. The investments that the trustees choose may not be suitable for each individual member. But KPERS members have no choice.

The point is that the individual is in control, and can choose investments that match their goals.

Featured Thoughts

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness — Declaration of Independence

The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people. — Ninth Amendment to the U.S. Constitution

Government is essentially the negation of liberty. — Ludwig von Mises

It is the responsibility of the patriot to protect his country from its government. — Thomas Paine

It does not take a majority to prevail, but an irate, tireless minority keen to set brushfires of freedom in the minds of men. — Samuel Adams

You do not know, and will never know, who the Remnant are, nor where they are, nor how many of them there are, nor what they are doing or will do. Two things you know, and no more: first, that they exist; second, that they will find you. — Albert Jay Nock

A major source of objection to a free economy is precisely that ... it gives people what they want instead of what a particular group thinks they ought to want. Underlying most arguments against the free market is a lack of belief in freedom itself. — Milton Friedman

As the coercive power of the state will alone decide who is to have what, the only power worth having will be a share in the exercise of this directing power. — F.A. Hayek

The kind of rules we should have are the kind that we'd make if our worst enemy were in charge. — Walter E. Williams

Your principle has placed these words above the entrance of the legislative chamber: “whosoever acquires any influence here can obtain his share of legal plunder.” And what has been the result? All classes have flung themselves upon the doors of the chamber crying: “A share of the plunder for me, for me!” — Frederic Bastiat

This was all before politicians gave us the idea that the things we could not afford individually we could somehow afford collectively through the magic of government. — Thomas Sowell

While the short-run prospects for liberty at home and abroad may seem dim, the proper attitude for the Libertarian to take is that of unquenchable long-run optimism. — Murray N. Rothbard

Barbra Streisand told Diane Sawyer that we're in a global warming crisis, and we can expect more and more intense storms, droughts and dust bowls. But before they act, weather experts say they're still waiting to hear from Celine Dion. — Jay Leno

The great virtue of free enterprise is that it forces existing businesses to meet the test of the market continuously, to produce products that meet consumer demands at lowest cost, or else be driven from the market. It is a profit-and-loss system. Naturally, existing businesses generally prefer to keep out competitors in other ways. That is why the business community, despite its rhetoric, has so often been a major enemy of truly free enterprise. — Milton Friedman

Increasingly, it seems that the biggest difference between conservatives and liberals is that the conservatives know government is force. But that doesn't stop them from using it. — John Stossel

One of the annoying things about believing in free will and individual responsibility is the difficulty of finding somebody to blame your problems on. And when you do find somebody, it's remarkable how often his picture turns up on your driver's license. — P.J. O'Rourke

Late one night in Washington, D.C. a mugger wearing a ski mask jumped into the path of a well-dressed man and stuck a gun in his ribs. "Give me your money!" he demanded. Indignant, the affluent man replied, "You can't do this. I'm a United States Congressman!" "In that case," replied the robber, "give me my money!" — Related by Walter Block

The libertarian creed, finally, offers the fulfillment of the best of the American past along with the promise of a far better future. Even more than conservatives, who are often attached to the monarchical traditions of a happily obsolete European past, libertarians are squarely in the great classical liberal tradition that built the United States and bestowed on us the American heritage of individual liberty, a peaceful foreign policy, minimal government, and a free-market economy. Libertarians are the only genuine current heirs of Jefferson, Paine, Jackson, and the abolitionists. — From "For A New Liberty: The Libertarian Manifesto" by Murray N. Rothbard

No matter how disastrously some policy has turned out, anyone who criticizes it can expect to hear: “But what would you replace it with?” When you put out a fire, what do you replace it with? — Thomas Sowell

Here’s Williams’ law: Whenever the profit incentive is missing, the probability that people’s wants can be safely ignored is the greatest. — Walter E. Williams

I would remind you that extremism in the defense of liberty is no vice. And let me remind you also that moderation in the pursuit of justice is no virtue. — Barry Goldwater

A society that puts equality — in the sense of equality of outcome — ahead of freedom will end up with neither equality nor freedom. The use of force to achieve equality will destroy freedom, and the force, introduced for good purposes, will end up in the hands of people who use it to promote their own interests. — Milton Friedman

When it becomes dominated by a collectivist creed, democracy will inevitably destroy itself. — F.A. Hayek

The most dangerous man, to any government, is the man who is able to think things out for himself, without regard to the prevailing superstitions and taboos. Almost inevitably he comes to the conclusion that the government he lives under is dishonest, insane and intolerable, and so, if he is romantic, he tries to change it. — H.L. Mencken

Of all tyrannies, a tyranny exercised for the good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron's cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end, for they do so with the approval of their own conscience. — C.S. Lewis

When the people find they can vote themselves money, that will herald the end of the republic. — Benjamin Franklin

What is euphemistically called government-corporate "partnership" is just government coercion, political favoritism, collectivist industrial policy, and old-fashioned federal boondoggles nicely wrapped up in a bright-colored ribbon. It doesn’t work. — Ronald Reagan

Those fighting for free enterprise and free competition do not defend the interests of those rich today. They want a free hand left to unknown men who will be the entrepreneurs of tomorrow. — Ludwig von Mises

The problem is big government. If whoever controls government can impose his way upon you, you have to fight constantly to prevent the control from being harmful. With small, limited government, it doesn’t much matter who controls it, because it can’t do you much harm. — Harry Browne

Life, liberty, and property do not exist because men have made laws. On the contrary, it was the fact that life, liberty, and property existed beforehand that caused men to make laws in the first place. — Frederic Bastiat

It is indeed probable that more harm and misery have been caused by men determined to use coercion to stamp out a moral evil than by men intent on doing evil. — F.A. Hayek

Freedom in economic arrangements is itself a component of freedom broadly understood, so economic freedom is an end in itself ... Economic freedom is also an indispensable means toward the achievement of political freedom. — Milton Friedman

Be thankful we're not getting all the government we're paying for. — Will Rogers

The American people will never knowingly adopt socialism, but under the name of liberalism, they will adopt every fragment of the socialist program until one day America will be a socialist nation without ever knowing how it happened. — Norman Thomas

[The political system] tends to give undue political power to small groups that have highly concentrated interests; to give greater weight to obvious, direct and immediate effects of government action than to possibly more important but concealed, indirect and delayed effects; to set in motion a process that sacrifices the general interest to serve special interests rather than the other way around. There is, as it were, an invisible hand in politics that operates in precisely the opposite direction to Adam Smith's invisible hand. — Milton Friedman

I'd rather be governed by the first 2,000 names in the Boston telephone directory than by the faculty of Harvard. — William F. Buckley Jr.

Liberty is not a means to a political end. It is itself the highest political end. — Lord Acton

The great virtue of a free market system is that it does not care what color people are; it does not care what their religion is; it only cares whether they can produce something you want to buy. It is the most effective system we have discovered to enable people who hate one another to deal with one another and help one another. — Milton Friedman

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow citizens. — Adam Smith

Democracy is a pathetic belief in the collective wisdom of individual ignorance. — H.L. Mencken

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard. — Alan Greenspan, “Gold and Economic Freedom” [1966]

Fundamentally, there are only two ways of coordinating the economic activities of millions. One is central direction involving the use of coercion — the technique of the army and of the modern totalitarian state. The other is voluntary cooperation of individuals — the technique of the marketplace. — Milton Friedman

The compelling issue to both conservatives and liberals is not whether it is legitimate for government to confiscate one’s property to give to another, the debate is over the disposition of the pillage. — Walter Williams

In Germany, they came first for the Communists,
And I didn’t speak up because I wasn’t a Communist;
And then they came for the trade unionists,
And I didn’t speak up because I wasn’t a trade unionist;
And then they came for the Jews,
And I didn’t speak up because I wasn’t a Jew;
And then ... they came for me ...
And by that time there was no one left to speak up.
— Pastor Martin Niemöller

There is no virtue in compulsory government charity, and there is no virtue in advocating it. A politician who portrays himself as "caring" and "sensitive" because he wants to expand the government's charitable programs is merely saying that he's willing to try to do good with other people's money. Well, who isn't? And a voter who takes pride in supporting such programs is telling us that he'll do good with his own money — if a gun is held to his head. — P.J. O'Rourke

The difference between libertarianism and socialism is that libertarians will tolerate the existence of a socialist community, but socialists can't tolerate a libertarian community. — David Boaz

When the people fear their government, there is tyranny; when the government fears the people, there is liberty. — Thomas Jefferson

After all, only the imagination limits the kind of laws and restrictions that can be written in the name of saving the planet. — Walter E. Williams

One of the methods used by statists to destroy capitalism consists in establishing controls that tie a given industry hand and foot, making it unable to solve its problems, then declaring that freedom has failed and stronger controls are necessary. — Ayn Rand

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the publick. ... It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. — Adam Smith

Act only on that maxim through which you can at the same time will that it should become a universal law. — Immanuel Kant

When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that justifies it. — Frederic Bastiat